Question

2. (6 pts) Minnie Corp. a US Company with no other foreign inflows or outflows, has decided to issue 80 million Euros worth of three-year bonds with a 5% annual coupon denominated in Euros at par. The company will use US dollars to buy the Euros need to pay off the bonds in years 1, 2 and 3. imillionan 4milion umilion a) If the Euro is expected to appreciate from its current level of $1.25 to $1.27, $1.29, and $1.30 in years 1, 2,and 3, respectively, what is the % cost of financing these bonds to the US company. IRR=6.4% flow %3D (.29 130 5.8 1.27 516 5.20 10000 b) If the Euro is expected to depreciate from its current level of $1.25 to $1.23, $1.22, and $1.21 in years 1, 2,and 3, respectively, what is the % cost of financing these bonds to the US company.21 1.21

Answer 1

a) The bond value is 80 million Euros and the coupon rate is 5% that means the annual interest payment is 4 million Euros.
1st year - Euro appreciates from 1.25 to 1.27 that means it will cost less to buy Euros
Percentage Change = ( 0.02 * 100 ) / 1.25 = 1.6%
5% - 1.6% = 3.4%

2nd year - Euro appreciates to 1.29
Percentage Change = ( 0.04 * 100 ) / 1.25 = 3.2%
5% - 3.2% = 1.8%

3rd Year - Euro appreciates to 1.30
Percentage Change = ( 0.05 * 100 ) / 1.25 = 4%
5% - 4% = 1%

Average Cost = ( 3.4 + 1.8 + 1 ) / 3
= 2.067%

b) Now Euro is expected to depreciate
Year 1 - Euro depreciates to 1.23
Percentage Change = ( 0.02 * 100 ) / 1.25 = 1.6%
5% + 1.6% = 6.6%

Year 2 - Euro appreciates to $1.22
Percentage Change = ( 0.03 * 100 ) / 1.25 = 2.4%
5% + 2.4% = 7.4%

Year 3 - Euro appreciates to $1.21
Percentage Change = ( 0.04 * 100 ) / 1.25 = 3.2%
5% + 3.2% = 8.2%

Average Cost = ( 6.6 + 7.4 + 8.2 ) / 3
= 7.4%